Proposal targets 'private' funds

Many would move overseas, some fear

The Treasury Department's blueprint for regulating American financial markets could impose more scrutiny on private-equity firms and hedge funds accustomed to being lightly regulated.

Under Treasury's long-term "optimal" plan, the Federal Reserve would be more than a central bank. It would also be a forensic accountant, entitled to review "detailed financial information" of any firm making investments that could rock the economy.

The blueprint said the Federal Reserve could require those firms to disclose information about their financial positions. And perhaps, most critically, the Federal Reserve could also force firms to take "corrective actions to address financial stability problems."

Robert Krause, managing partner for New Jersey-based www.HedgeFundDueDiligen cecom, said many hedge funds would move more operations offshore if America increased its regulation.

"Most hedge fund managers are very private; they have a style that works for them," Krause said. "While regulation is good to protect people, most of these are private partnerships. They're not designed for the public, but for sophisticated investors."

Hedge funds have total assets of nearly $2 trillion, according to the Hennessee Group, an investment adviser. It says hedge funds had an 11.64 percent return last year, compared with 6.42 percent for the Dow Jones industrial average.

U.S. law has exempted hedge funds from direct oversight because each of their investors has a net worth greater than $1 million.

Despite their private nature, hedge funds can have outsized public effects. In 1998 the Federal Reserve Bank put together a buyout of Long-Term Capital Management, a hedge fund with more than $120 billion in assets but with mounting losses that some felt would slam the economy. The fund ultimately lost about $4.6 billion.

And the current housing crisis fully surfaced this summer after the collapse of two hedge funds controlled by Bear Stearns Cos. that invested heavily in subprime mortgages. JPMorgan Chase & Co. agreed to buy a crippled Bear Stearns last month for a fraction of what it was worth a year earlier, a deal that hinged on the Federal Reserve's willingness to fund up to $30 billion of Bear Stearns' "less liquid" assets.

But endowing the Federal Reserve with a new regulatory role beyond its historical expertise also involves risk.

"This is going to be a new institutional mandate for the Fed and I think there are a lot of questions about whether they're the right agency for that," said Larry Ribstein, a business law professor at the University of Illinois.